Microsoft’s Quarterly Dividend Could Rise 13% YoY: Goldman

Microsoft Corporation (MSFT)’s board of directors could raise the company's quarterly dividend by 13% yoy from 31 cents to 35 cents per share at its upcoming board meeting, believe analysts at Goldman Sachs Group Inc. Heather Bellini and her colleagues said in report dated August 26 that they expect Microsoft to raise debt or repatriate cash to the U.S. to return more capital to shareholders.

Microsoft could announce 4-cent increase in dividend

Bellini and team point out that a 13% increase in the quarterly dividend is slightly above the 11% or 3-cent increase last year. They note that their analysis concurs with what the options market is pricing in. They add that this level of dividends, including their estimate for $13 billion to 15 billion in share repurchases for FY16, would imply that Microsoft’s total dividends plus share repurchases as a percent of free cash flow would decrease from 105% in FY15 to 86% to 89% in FY16:

Bellini and team suggest that a 13% increase in Microsoft's dividend payout ratio would make sense considering management’s buyback commitments through FY16 and based on their view that operating income growth excluding restructuring and integration costs would decrease 4% yoy in FY16 versus 1% growth in FY15. The Goldman Sachs analysts point out that a 4-cent increase is the midpoint between the 3-cent increase in FY15 and the 5-cent increase in FY14. The following table sets forth the dividend change implied by the options market versus the company’s actual changes in dividend:

A significant portion of Microsoft’s cash is offshore

Bellini and team argue that to aggressively return more capital to shareholders, Microsoft would have to repatriate cash or raise additional debt. The analysts note that a significant portion of Microsoft’s cash is offshore, so funding a large buyback or dividend would likely require a change to its capital structure.

 

In regards to raising debt, the GS analysts point out that with Microsoft’s debt-to-EBITDA ratio at 1.1x, the software major does have room to raise additional debt to help return more capital to shareholders:

The following table sets forth how much a 1.25x, 1.5x, and 2.0x debt to EBITDA ratio would impact the GS analysts’ FY16 EPS estimate:

 

The analysts note also that Microsoft has returned 39% to 105% of its FCF to shareholders in the form of dividends and buybacks from FY08-FY15:

Tracking Microsoft’s share price movements over the last five years, the analysts note that Microsoft’s stock reaction to dividend announcements has been in line or below the movement of the S&P 500:

Bellini and team reiterated their Sell rating on Microsoft and pegged their 12-month price target at $40 as they continue to see consensus’ FY16 and FY17 estimates coming down.